Corporations borrow money from banks in the form of loans. Loans may include amortizing term loans, institutional term loans, revolving credit lines, second lien term loans, and covenant-lite loans. In amortizing term loans, the periodic payments include partial payment of principal, similar to a mortgage loan. Institutional term loans are structured to have bullet or close-to-bullet payment schedules and are targeted for institutional investors. Revolving credit lines, also known as “revolvers,” are unfunded or partially funded commitments by lenders that can be drawn at the discretion of the borrowers. Second lien term loans have cash flow schedules similar to institutional term loans, except that the claims on borrowers' assets are behind those of first-lien term loan holders in the event of default. Covenant-lite loans are borrower-friendly versions of institutional term loans that have less than the typical stringent versions of institutional loan terms that restrict use of the principal or subsequent firm borrowing activities.
Banks may then trade or manage these loans like stocks and bonds. The loans are similar to bonds because both have regular coupon payments and a risk of default. However, the loans differ from bonds because they are private agreements (not securities), a floating rate instrument (little interest rate risk), quarterly coupon payments, prepayable at par on coupon dates, often collateralized, small interest rate risk, and term loans are often collateralized while revolving credit lines are senior unsecured.
In some instances, the loans may be traded or managed together in a portfolio. Unlike bonds, the loans often have a floating rate of return. Because most corporate loans trade infrequently, price discovery is difficult or impossible. There is no generally accepted method for computing market credit spread from loan prices. It is also difficult to calculate the effects of a risk of default and the ability to prepay at par. The limitations of standard loan pricing models make it difficult to manage risk in loan portfolios.